Donald Coxe – Investment Recommendations (December 2009)

The December edition of Donald Coxe’s Basic Points research report (subtitled “Financial Heroin”) has just been published. His investment recommendations, as summarized in this document, are listed in the paragraphs below, but I do recommend you also read the full report at the bottom of the post. (Also note that Donald’s weekly webcasts can be accessed from the sidebar of the Investment Postcards site.)

1. Remain underweighted in US equities – as a percentage of equities within global portfolios, and as a percentage of assets in US balanced portfolios. Underweight US bonds in global portfolios.

The long-term financial projections for the US are scary, even if one accepts the Obama assumptions: ten years of large deficits, no recessions, strong, sustained economic growth, and a mere 1% increase in Treasury yields. Those numbers make no allowance for the costs of health care, which will be huge. Debilitating tax increases are inevitable, even if the global warming “cap and tax” legislation does not pass.

2. Within US equity portfolios, underweight US economy-related stocks and overweight stocks tied to foreign economies.

US stocks outperformed after Obama’s election, but that created what could be called endogenous risk for investors. As long as the KRE [Regional Bank Index] continues to underperform both the BKX [Philadelphia Bank Index] and S&P, risks of a double-dip economy remain.

These markets should no longer be discounted heavily because of assumed gaps between their accounting and American practices. The credibility gap has been narrowed significantly. The FASB’s capitulation to Congressional pressure on big banks’ balance sheets is a sign that Volcker-style virtue is outdated.

Strong commodity-oriented companies are tied to global growth trends, led by the Asian powerhouses, which means they have less endogenous risk than companies tied to the US and Europe.

5. Emphasize gold stocks in commodity stock accounts.

Gold and other precious metals appear to have entered a period of above-average volatility, but the unprecedented creation of paper money and national debts means ownership of the metals and producers will tend to reduce endogenous risk in most portfolios. The stocks will tend to outperform bullion on the upside; the bullion will outperform on the downside.

6. Continue to overweight the agriculture stocks.

The best-performing commodity group in the past three months has been the agricultural stocks, led by the machinery and fertilizer stocks. Street analysts turned negative on these groups during the summer, when it looked as if US crop production would reach painful levels. Then the weather intervened. We remain of the view that the best of the agriculture stocks are among the best-quality core positions among all equities.

7. Maintain exposure to the energy stocks, but continue to emphasize oil producers and to de-emphasize natural gas producers.

Oil and natural gas are both in oversupply at the moment. The difference is that crude oil prices remain strong despite oversupply, as oil companies and speculators hoard oil in anticipation of stronger demand next year – and in fear of a new Mideast war. Shale gas may be too readily available to be good short-term news for either the profits or stock prices of oil and gas producers – but Exxon’s move on XTO Energy shows what having huge shale reserves can do for takeover values in politically-secure terrain.

8. Base metal stock prices are somewhat riskier than those of other commodity groups, but are worth holding.

The producers are dependent on China’s willingness to continue to buy more metal than it needs for current consumption.

9. Within balanced portfolios, emphasize long-duration, high-quality bonds at the expense of Cash. Canadian bonds should be used by foreign investors, where possible, as alternatives to Treasurys and US corporates.

Cash isn’t a true risk reducer, because it delivers no yield and cannot rise if there’s a new panic. If you must own something that pays you nothing, buy gold. In contrast, long-duration bonds are the best hedge against a renewed economic downturn.

The flip side to this is a wise balance sheet policy for Canadian companies. Borrowing in American dollars makes sense for Canadian exporters and resource companies – and for some other Canadian industries. Take advantage of (1) Bernanke’s heroin injections into US debt markets, and (2) Canada’s new financial prestige to reduce your endogenous currency risk by bulking up your borrowing in greenbacks.

Daniel: Well spotted. He got it right in most instances, but his mind wandered in paragraph 2 of the recommendations section. I have fixed the blog post, but obviously can’t change the original report.